(a) What are the sources of government revenue? (b) How does a government finance its budget deficit?

Answer Details

(a) Sources of government revenue. Government raises money from two broad groups of sources:

• Tax revenue: direct taxes (personal income tax, company income tax, capital gains tax, petroleum profit tax) and indirect taxes (import and export duties, excise duties, value added tax, sales tax).
• Non-tax revenue: royalties, rents and mining rights from natural resources such as oil and solid minerals; profits and dividends from government-owned enterprises; fees, licences, fines and court charges; interest on loans granted by government; grants and aid; and internal and external borrowing.

(b) How a government finances a budget deficit. A budget deficit exists when planned government expenditure exceeds expected revenue. It can be financed by:

1. Internal borrowing - selling treasury bills, treasury certificates and development stocks/bonds to the public, banks and the central bank.
2. External borrowing - loans from foreign governments, and from institutions such as the World Bank and IMF.
3. Running down reserves - drawing on accumulated surpluses or foreign-exchange reserves.
4. Deficit financing by creating money - borrowing from the central bank (in effect printing money), though this risks inflation.
5. Grants and aid from foreign or international bodies.

Examination reminder: separate sources of revenue (how normal income is raised) from deficit financing (how the shortfall is covered), and note that money creation is the most inflationary option.